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Spreads

Spreads involve combining multiple options to create a position with defined risk and reward characteristics.

1. Bull Spread with Call

  • Construction: Buy a call option at a lower strike price and sell another call option at a higher strike price, both with the same expiration date.
  • Objective: Profit from a moderate rise in the underlying asset's price.
  • Risk/Reward: Limited maximum profit and limited maximum loss.

2. Bull Spread with Put

  • Construction: Buy a put option at a higher strike price and sell another put option at a lower strike price, both with the same expiration date.
  • Objective: Profit from a moderate rise in the underlying asset's price.
  • Risk/Reward: Limited maximum profit and limited maximum loss.

3. Bear Spread with Call

  • Construction: Sell a call option at a lower strike price and buy another call option at a higher strike price, both with the same expiration date.
  • Objective: Profit from a moderate decline in the underlying asset's price.
  • Risk/Reward: Limited maximum profit and limited maximum loss.

4. Bear Spread with Put

  • Construction: Sell a put option at a higher strike price and buy another put option at a lower strike price, both with the same expiration date.
  • Objective: Profit from a moderate decline in the underlying asset's price.
  • Risk/Reward: Limited maximum profit and limited maximum loss.

5. Butterfly Spread

  • Construction: Combine a bull spread and a bear spread with three strike prices. Buy one option at the lowest strike, sell two options at the middle strike, and buy one option at the highest strike, all with the same expiration date.
  • Objective: Profit from low volatility when the underlying asset's price remains near the middle strike price.
  • Risk/Reward: Limited maximum profit and limited maximum loss.

6. Box Spread

  • Construction: Combine a bull call spread and a bear put spread with the same strike prices and expiration dates.
  • Objective: Typically used to exploit arbitrage opportunities when the combined options are mispriced.
  • Risk/Reward: The payoff is theoretically the difference between the strike prices, but practical considerations like transaction costs and early exercise can affect outcomes.
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